Virtually all economists working on climate change agree that we should price GHG emissions. Doing so creates an incentive to reduce emissions without the government directing specific technology adoptions or activity changes, that is, without “picking winners.”

Nearly as many economists agree that we should subsidize basic R&D. Doing so, accelerates the scientific breakthroughs that will be necessary to avoid even higher concentrations of carbon in the atmosphere. Of course, we can’t and shouldn’t subsidize all basic R&D regardless of how nutty the idea or indirect the connection to GHG reduction. We should subsidize the best ideas, that is, we should pick winners.

How does an economist hold both ideas in his/her head at the same time without risking spontaneous combustion? Actually, it’s not hard. The two policies are designed to solve two different problems. It’s no surprise that different problems require different solutions.

Pricing emissions recognizes that the normally efficient system of pricing goods and letting people choose what to buy and sell breaks down when some goods are not priced (negative externalities, for instance). Thus, putting a price on emissions fixes the problem that exists because we currently give away the right to pollute for free.

Pricing emissions is quite attractive compared to “command and control” pollution regulations, because the regulations don’t necessarily find the least expensive ways to abate the pollutant. Pricing the emissions gives every polluter the incentive to compare the emissions price to the cost of abatement and then do the abatement that is less expensive than paying the price for emissions. The regulator does not know as well as the emitters which are the most cost-effective abatement strategies. And – critically – there is an alternative to regulation that is almost certainly more efficient: creating a price for emissions.

Unfortunately, such an elegant solution hasn’t been discovered for the second problem, incentivizing innovation. The economics of innovation is like the engineering of electricity storage: a tremendously important field where progress has been frustratingly slow. Innovation is a key driver of the economy, but decades of economic study have revealed few reliable facts or verified theories of how innovation happens and how public policy can enhance it.

Still, it is well known that knowledge creation has huge spillovers that the knowledge creator doesn’t capture or profit from. Ironically, this is also an externality problem, but this externality is positive and results in too little innovation, in contrast to the negative externality of greenhouse gases that results in too many emissions.

Brightsource’s Ivanpah Solar Thermal Generator is one experiment that the U.S. government has picked to support

Intellectual property protection – patents, trademarks, copyrights, etc – are intended to address innovation incentive problems, but they are very imperfect solutions. One problem with IP protections is that they give the creator a monopoly for decades, which is probably not the best policy when we need cumulative innovations in a hurry to address climate change.

That brings us to subsidizing innovation. Among innovation scholars, subsidizing basic knowledge creation – fundamental science – is (you’ll excuse the expression) a no-brainer. Yes, it requires picking winners among basic science research proposals, but there isn’t an elegant alternative available as there is with the problem of negative pollution externalities. The spillovers from basic science research are huge, hard to measure or control, and almost certainly best left to diffuse without impediments.

More controversial is subsidizing downstream development and deployment, such as tax credits for building commercial-scale compressed-air power storage or a new nuclear reactor design. Some economists argue that firms can capture most of the knowledge created from these sorts of activities and can benefit privately. I used to be in that camp, but two things have changed my view.

First, I’m convinced there are significant knowledge spillovers that can’t be feasibly captured by a firm that develops or deploys new technologies. Furthermore, we wouldn’t want them to keep that knowledge to themselves even if they could. Importantly, the very fact that a firm is pursuing a new technology and is still in business — or has gone out of business — is a critical piece of knowledge to other firms considering work in the area. Seeing that a firm is making money in a new line of business inspires other firms to investigate the business and to investigate how the first entrant is doing it. Seeing a firm fail in a new venture is also valuable information to others considering similar activities.

That means that significant value from such experimentation spills over to other firms. It’s a problem in all industries, but it is especially a problem in an industry with very high costs of experimentation — building the first small modular nuclear reactor isn’t like creating a new social network app — and with very uncertain value of success. What makes the value of success so much more uncertain here than in most industries is the fact that the value will be driven as much by public policy towards climate change as by consumer demand.

The second thing that has changed my mind on subsidizing development and deployment of new energy (and energy efficiency) technologies is the need to solve the problem of globalclimate change. We desperately need the knowledge to spill over to the developing world so they will move out of extreme poverty along a much less carbon-intensive path than we have taken. We need innovations to be adopted as quickly and smoothly as possible around the world, a process that will almost surely be hampered by anything that relies on negotiations over intellectual property rights. Subsidizing innovation can be tied to disclosure and reporting requirements that encourage replication and further innovation.

Just as with fundamental science, this doesn’t mean that every technology should be subsidized throughout the development process. There are plenty of bad ideas out there that shouldn’t get money. There are also plenty of plans that may work privately, but for which the spillovers are small. Just as with fundamental science, this requires picking winners. And because these should be experiments – the whole point is to do things for which the outcome is uncertain — many “winners” picked will turn out to be failures.

And that’s ok. We need to pick, and subsidize, the experiments that have the largest potential to create value in reducing GHG emissions and the largest potential for that value to spill over to other uses, other technologies, and other countries. That’s not inconsistent with pricing GHG emissions. It’s just recognizing that we face multiple challenges in fighting climate change and multiple strategies will be needed to succeed.

Severin Borenstein is the E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business, where he teaches courses in Business Economics and Energy & Environmental Markets. He is also Co-Director of the Energy Institute at Haas and Director of the University of California Energy Institute. He has been a research associate of the National Bureau of ...

Remember the oil crisis in the 1970s? This was back when lots of people burned oil to make electricity? So what happened? The French Government picked winners ... nuclear. And the result? They've had clean electricity for 25 years. Elsewhere, nuclear was also successfully rolled out, although I don't know all the mechanisms, but the rollout broke the back of the oil crisis in about a decade and prices slowly fell.

It's now been 24 years since the IPCC AR1 and Governments got pretty firmly behind stopping climate change with Kyoto ... but by that period, the market had become the predominant religion and, as a clear consequence, very little has been done. In the US, with nuclear sidelined by the anti-nuclear movement, gas (which had been in decline during the oil crisis) took off. The triumph of gas in the US demonstrates the stupidity of both market mechanisms and the domination of short term thinking. Replacing coal by gas reduces emissions but can never get you to the low level required to roll back climate destabilisation. So after huge (but piecemeal) investment in gas infrastructure, you have to throw it all out and start again with a technology which is actually clean. How stupid is that? but what about renewables? If we had a hundred years and you don't mind maximising the area of wildlife habitat you cover in concrete, steel and glass, then fine. But we don't and I mind very much.

Picking which fission technology to rollout might be tough, but knowing that nuclear is the only feasible long term solution is blindingly obvious ... except if you are a market and driven by the things that markets value ... short term profit and feel good PR campaigns about how green you are!

We know what's needed to deal with climate change, but the market and the anti-nuclear movement are getting in the way.

I'm not sure what my friend Severin Borenstein is driving at when he says we should pick winners.

Venture funds pick potential winners (and many losers) all the time. What Borenstein seems to be saying is that government should pick winners, a proposition that fails the empircal test (Solyndra, etc.).

Having worked in government for 20 + years and issuing requests for proposals for various government sponsored water and energy projects, government should not be in the business of speculation (whether for energy technologies or financial investments). Those kinds of risks should be isolated to the private sector. Look at the state and local pension funds that have overpromised benefits based on speculative investments (the mortgage meltdown).

Then there is always the socological problem of bureaucracy and mission creep -- no matter how well intentioned the winner picking process, history tells us that it will evolve into a system of corruption and cronyism. I'm pessimistic about the proposal for government to pick winners.

I'm sure there are empirical studies which might shed some light on the success of government R&D. Most technological breakthroughs have come through serendipity rather than planning and winner picking.

Also, while there is obvious climate change as proven by deserts being former jungles or forests, the jury is still out about global warming. While I am an agnostic in such matters, the newer empirical studies are casting grrave doubt on the GW theory.

Moreover, air pollution is a problem created by natural geographic pollution traps, not solely pollution. California has basin topograrhy and air traps and thus has smog problems. California has 10 cities on the list of most polluting in the U.S. A state like Texas which imports raw coal to burn in its power plants has almost no cities in the top list of polluting cities. Why? Because Texas is a Plains State not a Basin State where pollution traps create smog. What might work in California would not necessarily work in Kansas and vice versa. For example, Texas has no higher asthma rates than California despite supposedly dirty power plants.

Global warming is a theory embraced by those in Basin States to eliminate imported power from Plains States in a regional energy trade war. Elites want to pick winner in Basin States so that energy markets don't produce negative side effects. But much of California's electricity is imported.

The problem with relying on imported power is that California and local cities don't collect the taxes whether they be sales, income, property, or municipal utility user taxes.

And aren't we just re-monopolizing the power grid when we pick winners based on their environmental benefits?

The simple fact that we have pushed the CO2 ppm above 400 is dread! Obviously, such a big planetas this will take time to fry. Actually, look up ocean anoxic event. It only takes a high level of CO2 to start it. During the OAE, the air itself is bad, causing the mass die off.

Nuclear IS a more powerful solution than fossil fuels. And obviously, FF's are quite a bit more powerful than RE. But the potential of today's nuclear is dwarfed by what's called the closed cycle. LFTR (liquid fluoride thorium reactor) is just one, rather under developed but proven concept. Here's a quote from energyfromthorium:

1.The LFTR produces energy cheaper than from coal. 2.The LFTR produces about 3% of the waste of a light water reactor of the same power and much of this "waste" can be extracted and sold within 10 years. Moreover, this waste need only be sequestered from the environment for 300 years, a far less daunting task than the 300,000 years required for todays LWR waste.3. The LFTR uses an inexhaustible supply of inexpensive thorium fuel.

Fast reactors are a little bit more developed. Here's more info from those that believe a fast reactor is more feasable than LFTR.

As Canadians are losing their water, air and land to toxicity from tar sands developments, we need to develop ALL non fossil sources, plain and simple!